Basel III - Impact on Indian Banks

Although, under Basel II, Indian Banks are adequately capitalized well above the minimum regulatory threshold of 9% Capital Adequacy Ratio, my study has highlighted the fact that in case Basel 3 changes get implemented in India, from the stipulated date in 2012, their would be substantial reduction in the Tier I Capital of Indian Banks with the % reduction in Tier I capital as high as 25% for IDBI,Central Bank, while a reduction range of 10-15% for SBI, PNB,Bank of India, Union Bank ICICI,Kotak,Yes Bank etc.

Hence, as per new definition of Tier I being predominantly common equity less some adjustments, my conclusion is that a substantial amount of money will be raised by Commercial Banks from Equity Market in a few years.

The conclusions above are very valid and it is big concern in Banking today.

1. Banks are expected to raise significant amount of equity or eligible capital once Basel III kicks in. Given that Indian Banks were better managed than there counterparts in US/UK (that had over 50X leverage), it would be little concern, but still a worry to raise capital cheap.

2. One of the things happening is that with the new banks coming into the scene in India, with RBI granting new licenses, this should pump additional capital into the system. So, whatever lending was with 20-30 banks would spread to 40-50 banks and the CRAR would be better at same capital base. Ie instead of raising capital, banks would reduce lending, which would happen naturally as competition increases.

3. Liquidity ratios and the recent changes makes significant impact on Banking business. Besides the regulatory CRAR requirements, banks would typically want to hold sufficient cushion to withstand shocks and so although the calculations you made for additional capital due to Tier I definition changes, the requirement for capital would be significantly more as Banks was to keep extra. This will create further squeeze to capital markets.

4. With so much additional capital maintained and host of other changes, experts are predicting ROE to fall drastically to sub 10%. So, banking is no longer a great business if not managed well.

5. Increasing NPA in PSU banks means higher capital requirements, hence more capital from markets.

6. General growth in Banking business to fund mega infra / govt projects means more capital. Banks need to fund the 67,000 crore 3G auction.

To conclude, capital raising for Banking sector is inevitable.

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